Portsmouth Company makes upholstered furniture. Its only variable cost is direct
ID: 2589400 • Letter: P
Question
Portsmouth Company makes upholstered furniture. Its only variable cost is direct materials. The demand for the company's products far exceeds its manufacturing capacity. The bottleneck (or constriant) in the production process is upholstery labor-hours. Information concerning three of Portsmouth's upholstered chairs appears below:
Recliner
Sofa
Love Seat
Selling price per unit
$
1,092
$
1,900
$
1,420
Variable cost per unit
$
700
$
1,300
$
1,100
Upholstery labor-hours per unit
7 hours
12 hours
4 hours
Required:
1. Portsmouth is considering paying its upholstery laborers additional compensation to work overtime. Assuming that this extra time would be used to produce sofas, up to how much of an overtime premium per hour should the company be willing to pay to keep the upholstery shop open after normal working hours?
2. A small nearby upholstering company has offered to upholster furniture for Portsmouth at a price of $44 per hour. The management of Portsmouth is confident that this upholstering company’s work is high quality and their craftsmen can work as quickly as Portsmouth’s own craftsmen on the simpler upholstering jobs such as the Love Seat. How much additional contribution margin per hour can Portsmouth earn if it provides the raw materials to the nearby company and then hires it to upholster the Love Seats?
3. Should Portsmouth hire the nearby upholstering company?
Recliner
Sofa
Love Seat
Selling price per unit
$
1,092
$
1,900
$
1,420
Variable cost per unit
$
700
$
1,300
$
1,100
Upholstery labor-hours per unit
7 hours
12 hours
4 hours
Explanation / Answer
answer:
1
The company can determine how much they would be willing to pay by computing the contribution margin per unit of the constrained resource:
Selling price
1900
Less Variable cost per unit
-1300
Contribution margin per unit (a)
600
Sofa time required to
produce one unit (b)
12
Contribution margin per unit of the constrained resource (a)/(b)
$ 50
per hour
The Company should be willing to pay at least $50 per hour
_____________________________________________________________
2
Use the contribution schedule and divide the contribution margin per unit by the constrained resource required per unit to determine the contribution margin per unit of the constrained resource
Recliner
sofa
Love seat
SP per unit
$ 1,092.00
$ 1,900.00
$ 1,420.00
VC/unit
700.00
1,300.00
1,100.00
CM/unit
(a)
$ 392.00
$ 600.00
$ 320.00
Upholstery shop time required to produce one unit
(b)
hours
7
12
4
CM per unit of the constrained
resource
(a)/(b)
per
hour
$ 56.00
$ 50.00
$ 80.00
________________________________________________
3
Should Portsmouth hire the nearby upholstering company?
Answer:
All 3 units are worth more than the $44 cost so the company should accept the offer. The freed up time could be used to upholster more love seat in order to increase total production and sales of this unit. The time used would be worth $80/hr. If there is no more capacity for additional production of the love seat, the company would have additional time to produce more of the other 2 chairs, which would both be more than $44 per hr.
Selling price
1900
Less Variable cost per unit
-1300
Contribution margin per unit (a)
600
Sofa time required to
produce one unit (b)
12
Contribution margin per unit of the constrained resource (a)/(b)
$ 50
per hour